Tuesday, March 4, 2008

Gold spiked to another new record high yesterday, this time to $989

Not coincidentally, the precious metal peaked the very moment the dollar index attained its latest record low. Also, as with the dollar, gold backed off its latest record this morning, and trades for about $983.

“If you’re worried about the U.S. economy,” says Kevin Kerr, “buy gold. If you’re not worried about the Chinese economy, buy some more gold.

“Gold demand in China relative to GDP is about five times higher than in the U.S. Also, for several years, Yu Yongding, a committee member of the People’s Bank of China, has advised that China use its foreign currency reserves -- the largest in the world -- to buy gold. He’s not the only one. Other Chinese economists are urging their government to QUADRUPLE the nation’s gold reserves.”

As we’ve noted here in The 5, China reports that less than 1% of its $600 billion in reserves are held in gold. Should the country move even a fraction of the trillion-plus in dollar reserves it has into gold, you could see a spike of historical proportions.

esterday, the Dow held steady, after falling 315 points on Friday. Gold rose again – another $11...to $986. It looks like $1,000 gold is only days away, which means that $2,000 gold can’t be far behind. And when it gets here, we know our Dear Readers will be ready. Find out how you can prepare yourself to fully profit from this epic rise in prices here .

This is the big month, when mortgage resets peak out – with nearly $120 billion worth of mortgages being adjusted upwards. Naturally, you’d expect Americans to be feeling pinched...especially with prices of energy and food at record levels.

“Americans start to curb their thirst for gasoline,” says a Wall Street Journal headline.

Car sales fell in February – as you’d expect. Retailers report slower sales. And the economy itself, when last measured, was neither moving ahead...nor retreating, but stock still.

This has prompted a rush to judgment on the part of some critics:

“The Federal Reserve’s Rescue Has Failed,” announces a headline in the English paper, the Telegraph . Ambrose Evans-Pritchard, the paper’s business editor, says, “The verdict is in. The Fed’s emergency rate cuts in January have failed to halt the downward spiral towards a full-blown debt deflation. Much more drastic action will be needed.

“Yields on two-year U.S. Treasuries plummeted to 1.63pc on Friday in a flight to safety, foretelling financial winter. The debt markets are freezing ever deeper, a full eight months into the crunch. Contagion is spreading into the safest pockets of the US credit universe.”

Mr. Evans-Pritchard then brings up New York’s Port Authority, which operates bridges, bus terminals and airports in the New York, New Jersey area. The Port Authority is backed by both state and federal governments. Yet, when it went to borrow money, it was treated like the junkiest of junk credits...forced to pay 20% rates.

“I never thought I would see anything like this in my life,” said James Steele, an HSBC economist in New York.

“No sane mortal needs to know what term-auction means, except that it too became a tool of the U.S. credit alchemists,” continues Evans-Pritchard. “Banks briefly used the market as laboratory for conjuring long-term loans at Alan Greenspan’s giveaway short-term rates. It has come unstuck. Next in line is the $45 trillion derivatives market for credit default swaps (CDS).

“Sub-prime debt is plumbing new depths. A-rated securities issued in early 2007 fell to a record 12.72pc of face value on Friday. The BBB tier fetched 10.42pc. The ‘toxic’ tranches are worthless.

“Why won’t it end? Because US house prices are in free fall.”

The article goes on to mention that we are only half way through the mortgage-reset storm . Expect more bad weather, says Evans-Pritchard.

But here at The Daily Reckoning , we are in no hurry to pronounce judgment on Ben Bernanke’s plan to save the U.S. economy. We don’t have to. We knew it was a mistake from the very beginning. Exactly how the markets would react, we couldn’t say. But the idea of rescuing people from too much debt by lending them more money struck us a bit like serving martinis at an AA meeting; it was bound to lead to trouble.

The trouble we seem to be getting is popularly known as ‘stagflation.’ Prices rise, but so does unemployment. It wasn’t supposed to work that way. Inflation was supposed to spur consumers to spend money and businesses to hire people. But people eventually catch on to the trick. They eagerly get rid of money...and prices do rise. But they also come to realize that it’s not a real boom...but a phony boom... So, businesses do not expand...do not hire...and do not earn more money. They raise prices, but their costs go up too.

Still, the ‘stagflation’ label is reassuring to people. Those over the age of 40 can recall the stagflation of the Nixon years. In retrospect, it didn’t seem so bad. But there, too, we part company with most observers. It wasn’t so bad then because America’s economy was much, much stronger – strong enough to take Paul Volcker’s bitter medicine...and survive.

This time, the financial authorities aren’t even opening the medicine cabinet. They’re afraid the patient couldn’t stand the treatment. Instead, they’re administering the old elixir that got the economy into serious problems in the first place – more cash and credit.

Different circumstances...different treatment...we will surely get a different result. Stay tuned...

*** The costs of the credit crunch are mounting up. Each estimate is bigger than the one than before it. The latest estimate from the Union Bank of Switzerland is $600 billion. Economist Nouriel Roubini goes even higher – at $1 trillion. Of course, those are just the direct losses...the disappearing cash. There are also losses in implied wealth (and subsequent changes in spending and retirement plans) from falling house prices themselves. The residential housing market is worth some $20 trillion. If it goes down 30% from top to bottom, as expected, that’s a loss of more than $6 trillion.

*** Remember the Golden Rule: He who has the gold makes the rules.

As nations get rich, typically, they buy gold – or steal it. What else can they do? How else can they protect their wealth?

When Britain was the world’s dominant empire, it loaded up so much gold in the Bank of England that the floor collapsed. Then, power shifted to America. The United States collected its war debts and the gold went back to the U.S.A with the doughboys. In a few years, the United StatesFort Knox, Kentucky. had the world’s largest stockpile, in

In 1971, Nixon announced that the United States would no longer honor foreign claims on its gold – after Charles de Gaulle insisted on turning in dollars for the metal in the 1960s. Since then, the world has operated on a dollar standard. Foreign governments stockpiled dollars, rather than gold, and trusted the U.S. Treasury to make sure their dollars didn’t lose too much value.

Alas, lose value is just what the dollar did . It went from about $1 down to 5 cents during the 20th century. But the drop was fairly gradual...and other currencies fell along with it – more or less. And the U.S. economy was so strong and so far ahead of the rest of the world, people felt safe holding the greenback, even though it was losing value steadily.

But now, two things have changed.

First, wealth is shifting away from the United States. America is no longer a growing power, but a fading one. The real money is being made in other places. The energy exporters, for example, are piling up money – especially dollars – at breakneck speed. And the Asian exporters too are making trillions.

Second, the world is losing confidence in the dollar as never before. Everyone knows the Bernanke Fed can’t defend the buck. There are too many of them. Instead, Bernanke has to try to fight the economic slump – with more cash and credit...further inflating the world’s supply of dollars.

That’s why the dollar index is at its lowest level in 35 years.

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